By CoBS Student Editorialist Kunal Ganorkar, based on the research paper Donate Money, but Whose? An Empirical Study of Ultimate Control Rights, Agency Problems, and Corporate Philanthropy in China, Justin Tan, Yuejun Tang

Stronger brand value, better relationship with stakeholders and improved financial performance – these are just a few of the myriad benefits arising from corporate philanthropy. Yet, it has been found that less than 1% of Chinese firms make charitable donations and a vast majority have no philanthropic agenda whatsoever. Why is China lagging so far behind the US and Europe when it comes to charitable giving? Surely it is not due to a lack of resources. China, after all, is perfectly cut out to surpass the US as the world’s largest economy by 2030. It has lifted more people out of poverty than any other country. What, then, is keeping Chinese firms from donating?

Tunneling: A crippling affliction in Chinese firms

The answer lies in the corporate governance of Chinese firms. Chinese companies have a pyramid control structure whereby the ownership is highly concentrated in the hands of a few. More often than not, these few shareholders end up exploiting the rights and interests of small- and medium-sized shareholders, by virtue of their superior controlling powers. In other words, they engage in “tunneling” activities to channel private benefits towards themselves at the cost of the minority shareholders’ interests.

The ultimate controllers are unlikely to devote their resources to corporate philanthropy because the tunneling effect promises a much greater earning potential than corporate philanthropy does. Also, any benefit arising from corporate philanthropy would have to be shared with all shareholders while the fruits of tunneling activities are reserved exclusively for the ultimate controllers. Our study with 1,100 Chinese A-share listed companies revealed that the higher the voting rights of ultimate controllers the lower their ratio of charitable donation to revenue. Instead the ultimate controllers readily turn to tunneling behaviors for private gains.

Whose money should Chinese firms donate?

Interestingly enough, although ultimate controlling shareholders in A-share listed companies are reluctant to donate assets they control, they are more willing to donate if most of the money comes from minority shareholders. While ultimate controlling shareholders have greater voting rights than the other shareholders, they often have much lower cash-flow rights. This means that most of the corporate resources actually come from the minority shareholders, but it is the ultimate controllers who decide how to utilise these resources. In such cases, ultimate controllers donate some money that belongs to minority shareholders in pursuit of a win-win scenario whereby they get to enjoy the benefits of corporate philanthropic behaviors without spending any of their own resources. We found that the greater the deviation of voting rights and cash-flow rights among private enterprises, the higher is their total donation ratio.

Are we really donating for the right reasons?

Private enterprises (PEs) fare relatively better than state-owned enterprises (SOEs) when it comes to corporate philanthropy in China. They tend to engage in corporate philanthropy, albeit with the resources of minority shareholders, to boost political legitimacy and acquire precious resources, ranging from fewer government regulations to preferential tax policies and restricted competition. The SOEs, on the other hand, are less motivated to donate – even during times of crisis. For example, we discovered that after the devastating Wenchuan earthquake of 2008, the ultimate controllers of A-share listed private enterprises offered more donations than those of state-owned enterprises.

Unfortunately, a lot of the magnanimity of giving fades away when we realise that many PEs consider corporate philanthropy merely as a kind of insurance against their tunneling activity. For such enterprises, philanthropy serves as nothing more than an enticing opportunity to discourage external monitoring by minority shareholders, and mask tunneling behaviors.

The silver lining

Yes, Chinese firms are indeed ‘tunneling’ their way out of corporate philanthropy. They are disproportionately more focused on tunneling activities than on charity. However, despite our dismal findings, we still harbour hopes as business ethics and institutional reforms continue to evolve in China. The government could play a critical role here by encouraging strategic philanthropic behaviour, supervising social responsibility and increasing tax allowances. A tighter supervision over the pyramid structure can surely serve to prevent the ultimate controllers from gaining private benefits by donating only the money that comes from minority shareholders.

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